How to Create a Great Financial Plan
As we wrote in our article Everything You’ve Always Wanted to Know About Financial Planning, creating a financial plan is a good reason to sit down and think seriously about what your startup goal is, what stage you are in, what resources you need, how you will work with them and what you want to achieve. A financial plan is actually a numerical representation of a business plan that reflects all areas of the business plan. Without a financial plan, you won’t be able to do business well.
So what should a financial plan look like?
Similarly to a business plan, it should be:
- Complex: it should describe the whole project
- Linked: individual parts should be connected to each other
- Realistic: it should be based on real data and respect market constraints
- Precise: it must not contain numerical errors
- Variable: it should allow a quick change of key parameters
- Clear: everyone should understand it
- Periodic: it should cover individual months or another period in line with the product
- Complete: no part may be omitted or incomplete
Maybe you're wondering if anything so perfect is possible. Well, it is! Step by step, we'll show you how to do it.
1. Define Your Product or Service
Before you start making a financial plan, you should clearly define your product or service, namely the Minimum Viable Product (MVP). Think about what features and functionalities your MVP should have and keep these in mind during product development. It often happens that startups continuously polish their product and never actually deliver it to the market. Remember: new features can come later. In the initial phase, it is necessary to get the product into a viable form.
If you are not sure what an MVP is, a detailed explanation can be found in our interview with Petr Šídlo.
2. Calculate All Costs
Divide your costs into categories so you can best orient yourself. First, write down direct costs associated with the creation of the MVP, which may be, for example, IT developer costs (in case you are developing a software app) or cricket flour, fruit, and other raw materials (in case you are producing cricket energy bars). Then think about what you need to secure these direct costs. That would likely mean renting an office and procuring IT equipment, administrative staff, legal aid, an accountant, a tax consultant, a graphic studio, and so on... Indirect costs are many and they all need to be taken into account.
Once you have calculated all costs, be sure to add a reasonable financial reserve – it is recommended to add 5-20% of total costs, always based on the type of the project and negotiation with the investor. The bigger your reserve is, the smaller the risk that you will come up short financially.
And one more piece of advice: make sure you do not leave anything out. You might want to check the costs several times on your own and consult with colleagues or experts. There is nothing worse than finding out that you have missed an item in the process. It's like flying a plane to a distant destination and finding out in the middle of the journey that you have only a tenth of the remaining fuel.
3. Define Your Business and Marketing Strategy
Now you have to think about how to get your product to end users. You can have your own salespeople; sell through business partners like supermarkets or specialized stores; have your own store; or sell through your e-shop, internet platforms, or other indirect sales representatives. Each of these strategies entails some costs and requires a different approach. You should choose the strategy that will best pay off for you based on your product.
If you have already selected a business strategy, you should describe the conversion funnel in the financial plan. What is conversion funnel and what does it look like?
Let's say a potential customer sees your Facebook ad about your handmade hats. This type of customer represents the top of the funnel. Said another way, a lot of people will see the ad, but only a few will actually click on it; thus, the funnel narrows down. Some people will see the product and close the page, and the funnel will get smaller. The narrowest part of the funnel reaches its end point with the people who put your hat in the basket and buy it.
After describing the conversions in detail, you should consider your marketing communication. Will you offer a premium luxury product, a specialized product for tech people or a cheap mass product for everyone? If you are selling Ferrari, you’ll need to use different language than if you are selling Volkswagen. Marketing, branding, and channel selection should match product targeting.
4. Think About Pricing
The product price must match the chosen business and marketing strategy and must be acceptable for your target audience. When creating the price, you should test the price sensitivity of your customers.
If you decrease the price of your product by 10%, will this change in fact increase your sales? The answer is yes if you sell at least 10% more products. The same applies if you increase by 30% but sell 5% fewer items. Selling a large number of products doesn’t always have to be as profitable as it seems. Aim to sell the optimal number for the optimal price.
5. Calculate Revenues
To calculate revenues (a number of sold products x determined price) you can choose either the bottom-up approach or the top-down approach. We’ll show you how both approaches work.
Let's say you have a startup with ten employees and you sell energy bars. You have enough money to hire three salespeople, each of which will cost you 1,000 EUR per month. An average salesperson is able to contact 150 companies per month, meet one third of them, continue to negotiate with 40% of them and in the end close the deal with one tenth of them. Based on this calculation, you will get 20 potential customers per month, two of which will be pay you x amount of money for your product.
If you choose a top-down approach, you will be interested in how big the European energy products market is. Once you find this number, you need to find out what percentage of this market makes energy bars. Subsequently, you have to say objectively what markets or countries you are able to address and then quantify how much traction of this market you can get with your products. In this way, you estimate your revenue.
When calculating revenues, it’s necessary to monitor not only the absolute number but also a number of other factors such as weekly or month-to-month sales growth, breakdown of sales by individual customer segments, average sales in a given segment of customers, and other indicators. You should not only settle for the final number but understand its causes.
6. Add Financial Statements
If you have calculated costs and revenues, it’s high time to compile financial statements: profits and losses, balance sheets and cash flow. There are plenty of guidelines on how to create these reports on Google. We just want to remind you that you should keep an eye on cash flow and the so-called burn rate, i.e. how much money your startup "burns" over a certain period of time, which are key indicators of financial management and are very important for investor decision-making. So give these reports your full time and energy.
7. Create Three Scenarios
If you’ve reached point 7, you probably have the first version of your financial plan. Congratulations! At this point, however, you’ll still need to select 5-10 most important inputs that can fundamentally affect the outcome of your startup in case they change over time. This may be price, the length of the sales cycle, the conversion of paying customers or the cost of acquiring potential customers.
Once you’ve selected these inputs, you should create three scenarios: pessimistic, realistic and optimistic. The plan you’ve created so far is based on real numbers. Now think about where the numbers could move if things go extremely wrong or well. Add the pessimistic and optimistic scenarios to your financial model and see how the revenues, profits, and cash flow change. Thanks to these scenarios, you’ll realize the different directions your project can go in.
8. Write a Summary
At this point, it is likely that your financial plan is a fairly comprehensive and long document, or more precisely, an Excel spreadsheet that only you how to work with. However, if you want to show your plan to investors or employees, you should present the most important points in a clearly arranged summary.
Each such summary should include simplified financial statements, a summary of the most important variables (e.g. the number of registered and paying users or the number of sold products) and financial indicators (such as sales growth or sales margin). We recommend that you add charts and other visual elements to the plan.
9. Specify the Type of Financing
When you put costs for 2-3 years and sales together, you should get the amount you need for your business. Once you know the amount needed to finance the project, you should decide what funding sources to use. You can use your own savings or money from the FFF group – that is, family, friends and fools.
You can also opt for crowdfunding or angel investors, take a classic loan from a bank, reach out to an investor or combine more resources.
10. Select KPIs and Check the Plan Regularly
In conclusion, you should select 5-10 Key Performance Indicators (KPIs) that you will be tracking on a weekly or at least monthly basis. These may be the average acquisition cost per customer, the average product cost, the conversion rate, the quantity of products sold, or the percentage of outbound customers. The ideal KPIs vary depending on the startup. The more these outputs deviate from the original plan, the more you will need to update your plan.
That’s it! You’ve learned how to create a financial plan in 10 steps. If you have any further questions about financial planning, don’t hesitate to read the follow-up article Everything You’ve Always Wanted to Know About Financial Planning and watch our video on Facebook.
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